What does 'liquidity' refer to in a financial context?

Liquidity refers to the ease with which an investment or asset can be converted into cash without significantly affecting its market price. In financial contexts, liquidity is crucial because it determines how readily available a resource is for transactions or financial operations.

When an asset has high liquidity, it means that it can be sold quickly in the market at a price that is close to its prevailing market value. For example, cash itself is considered the most liquid asset, while real estate and collectibles may take longer to sell and may require a discount to complete a sale, indicating lower liquidity.

Understanding liquidity is essential for managing cash flow and ensuring that an entity can meet its short-term obligations, making it a fundamental concept in finance and risk management.